The Development of Wescott’s Asset Allocation Policy

March 13, 2010

Wescott’s Asset Allocation Policy has been developed after years of research and observations, and is built upon a deep foundation of academic and economic research. We begin with an analysis of long term historical performance trends or the various asset classes, utilizing the University of Chicago’s Center for Research in Security Prices (“CRSP”). We then overlay our forward looking observations that come from academic studies, research about global trends and demographics and our many conversations with managers to ensure that our Asset Allocation Policy is well positioned for the future, rather than focusing on how it would have worked in the past.

Our Asset Allocation Policy focuses on diversification on several fronts.

Our decision about geographic diversification is influenced by the composition of the MSCI All Country World Index, as well as government resources, including Federal Reserve Research and Data, the National Bureau of Economic Research, and The World Bank. We also incorporate what we learn from our conversations with managers who share what they are seeing in their analysis of companies and developments within the countries they visit. In addition to MSCI performance and statistics, we have followed research generated by Ibbotson, Brinson and Beebower and academics associated with Dimensional Fund Advisors (“DFA”). Our decisions about geographic diversification are long term in nature are not frequently adjusted. The last adjustments were made during 2005 and 2006.

Our decisions about diversification within asset sub-classes has been greatly influenced by the multi-factor valuation model developed by Professors Fama and French and Rex Sinquifield of DFA. The Fama and French “Three Factor Model” for equities demonstrates the size and value factors as determinants of excess returns, based upon CRSP data. Their research has demonstrated that the effect of these factors is global, and not limited to U.S. companies. Based upon the “size effect” we have an allocation to small companies that is overweight to the market. Small (including micro cap) companies have historically outperformed large companies on a persistent and global basis. Small companies are greater in number than large companies, and they are less followed by analysts, providing a high level of market inefficiency that can be exploited by exposure to this area of the market.

We also dedicate an allocation to mid-sized companies, which have faster growth rates than large companies (or are out of favor former large companies poised for a turnaround). Also, mid-sized companies tend to be more established, recognizable brand names with merger and acquisition activity, however, they become overshadowed by the larger companies in the broad market indices, which dilutes the impact of their performance on the portfolio. Our approach is to underweight large companies that dominate the benchmarks yet have lower expected returns in favor of mid-size and small companies which have higher expected returns over long periods.

The “style effect” is that out of favor, “high book value to market value” companies outperform “growth” companies over long periods of time, for those patient enough to buy undervalued companies and hold them until their intrinsic value is recognized. While long-term historical patterns are very strong, this is an area in which we make over-riding shifts in our allocations by style to be responsive to changing market conditions. We believe that any company can be “growth” or “value” at a given point in time. No company is immunized from a change in fundamentals due to poor management, poor economic conditions or disappearing industries, and all companies have the opportunity to reverse course and grow by taking advantage of new management and innovations. During the late 1990s there were very few popular companies dominating market returns. From 1995 through 2002 we maintained a significant overweight to our value managers as we believed that they had a much broader opportunity set than the growth managers who had been led to very concentrated areas of the market (primarily to technology, media and telecommunications). Beginning in 2002 we gradually reduced the overweight to value as we observed that managers of both growth and value styles had comparable opportunity sets (for example, technology became “value” and energy became “growth.”) Since 2006 we have maintained a neutral weight to domestic equities, while maintaining a value bias to our Non-U.S. equities due to the dynamics of varying accounting systems, currency fluctuations, and geopolitical factors.

The Fama and French “Five Factor Model” includes two Fixed Income factors: sensitivity to term risk and sensitivity to default risk. Their research has influenced our bias to short and intermediate bonds of high credit quality, in that relative to equities, there is insufficient reward for taking credit and term risk in fixed income investments.

The Implementation of Our Asset Allocation Policy:
Once our allocation policy is determined, we employ managers within each of the categories. In order to take advantage of market sentiment, we do not expect our managers to track the benchmarks consistently, however we expect them to outperform their respective benchmarks over full market cycles. We monitor global developments, the holdings of our managers, and economic data. We attend many meetings with professionals at well-regarded investment firms, in addition to the meetings we have with managers hired for our clients’ portfolios. We are able to leverage the research of many firms, assimilate differing views and arrive at our own outlook and perspective, which guides our Asset Allocation Policy.

Our Asset Allocation Policy guides the selection of managers. We believe that this provides a sustainable discipline, which combines Historical Perspective and a Forward Looking Outlook for successful Portfolio Construction.

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